Special Needs Trust and 529A (ABLE) Accounts

Special needs trusts are usually set up by clients who have disabled children who may be receiving supplemental Social Security (SSI) benefits or other federal or state assistance. These trusts are designed so that the parents can offer their disabled child some benefits without disqualifying them for the government assistance, most of which are means-tested, provided if the child has no other significant resources. These types of trusts can also be used for disabled parents.

Medicaid benefits are extended only to those disabled recipients who have minimal assets or income. Hence, a primary goal of the special needs trust is to design the trust so that government benefits are used to meet the basic needs, such as food, clothing, shelter, while the trust provides supplementary needs, such as medical care, special equipment, utilities, education, job-training, or entertainment.

To qualify for the program, many parents will transfer assets that are considered exempt assets under Medicaid, such as a personal residence in which a spouse resides, but not the proceeds of life insurance, annuities, IRAs, pension benefits, or other sources of money or income since such resources, unless they are significant, can be quickly depleted in caring for a disabled child.

Special-needs trusts have 2 types: a first-person, or OBRA, trust, named for the Omnibus Budget Reconciliation Act (OBRA) of 1993, and a 3rd-party trust, usually set up and funded by members of the disabled person's family.

  1. OBRA trusts are funded by the beneficiary, usually from the proceeds of insurance or a lawsuit. Money remaining after the beneficiary's death and after paying funeral expenses is usually forfeited to the government to reimburse it for the expenses it has paid for the beneficiary or to the organization that provided the funds, often a provision of a lawsuit settlement since the organization may offer a bigger settlement if it receives any amount remaining after the beneficiary's death.
  2. Third-party trusts are set up by family members, typically the parents, but money remaining after the beneficiary's death can go to other children or other designated beneficiaries.

Medicaid Eligibility for Trust Beneficiaries

Sometimes trusts are used to support an individual in such a way so that they qualify for Medicaid — a federal program administered by the states that provides medical care for people who cannot afford it. Eligibility for Medicaid will include trust income and principal to the extent that the beneficiary can access those funds. For instance, if the beneficiary is also the settlor, then all the trust funds available to the settlor-beneficiary will be included as resources available to the Medicaid applicant.

If the beneficiary is not the settlor, then all the trust income and principal that the beneficiary should receive or could demand will be considered resources available for their use. Hence, mandatory trusts that must pay a certain amount will be included in the beneficiary's income and income that must be paid out by a support trust to support the beneficiary. However, if the trust is irrevocable, then only those funds available to the beneficiary will be included in the beneficiary's assets, unless it is a testamentary trust created by the spouse's will or if the trust was created for a disabled person and the trust document specifies that the government will be paid for all unreimbursed medical expenses after the beneficiary dies.

Because the government is providing basic support for the individual, spendthrift clauses in discretionary trusts do not apply. However, there is an exception for a supplemental needs trust that exists to provide support for medical services that the government does not cover.

The trustee is required to cover the needs of the disabled but without making them ineligible for public assistance. Thus, the special needs trust does not provide basics, such as food, clothing, shelter, or medical care. If the trust assets can be used to pay for basic living expenses, then the government may treat the trust assets as available and compel the trust to pay for the basic needs of the disabled or the government may even compel reimbursement of government payments already received. Instead, the special needs trust usually pays for health expenses, special transportation for the child, occupational therapy, and other educational services.

To exclude trust assets as a resource for support, the access must be restricted, structured much like a trust used for asset protection. The trust document should specifically provide that the trustee will not be permitted to pay for items covered by public assistance programs. Otherwise, the trust assets will be considered an available resource for the support of the disabled child. An independent trustee should be used and the trust should be an irrevocable trust, but one created as a testamentary trust, at the death of the last surviving parent. The trust should have contingent beneficiaries, such as other children, who would become the beneficiaries if the trust assets are being sought by government officials to cover the expenses of the disabled, even providing a destruct clause, terminating the trust and distributing it to the contingent beneficiaries.

Special needs trusts are also often used to hold the proceeds of a lawsuit and may be established by a parent, guardian, or the court. The trust document should specify special payback provisions, stipulating that Medicaid will be reimbursed for any medical assistance granted to the beneficiary.

Beneficiaries should be specified for the trust to receive the assets after the disabled child dies. The trust can be revocable or irrevocable, but is generally advised to be irrevocable. Parents can also act as trustees, but many authorities advise using a disinterested 3rd party.

529A Accounts [Achieving a Better Life Experience (ABLE) Accounts]

The tax code, specifically IRC §529, has been amended to allow a new type of account called the ABLE account or 529A account to help families save private funds to support individuals with disabilities. Based on the Achieving a Better Life Experience (ABLE) Act of 2014 and modeled after 529 educational accounts, 529A accounts were designed to supplement — but not supplant — private insurance benefits, Medicaid, employment, and other sources. Previously, assets exceeding $2000 would disqualify the disabled from public benefits like Medicaid and Supplemental Social Security Income (SSI), but the 1st $100,000 in an ABLE account will be exempt from the $2000 individual resource limit imposed by SSI. However, check with the state administering this account for additional information about this exemption.

Eligibility for these accounts include anyone receiving benefits under SSI or the Social Security Disability Insurance (SSDI) and individuals who meet the Social Security Administration definition and criteria for functional limitations, certified by a letter from a licensed physician. The disability must have started before age 26, but starting in 2026, the eligibility age will rise to 46.

Like other 529 plans, the states must provide the legal foundation to create the accounts — they are not established by federal law. Also like other 529 plans, taxpayers do not have to live in the state to use a state's 529 plan, an account can be set up in most states, regardless of where the taxpayer or child lives. However, some states do limit their programs to residents of the state. The ABLE National Resource Center, managed by the National Disability Institute, maintains a map detailing each state’s ABLE program and a tool to compare up to 3 ABLE plans simultaneously, making it easier to find the best program.

Cheaper and easier to set up than a special-needs trust, anyone can contribute, but annual contributions cannot exceed the gift tax annual exclusion per year per beneficiary (2024 limit: $18,000). Certain beneficiaries who work are permitted to contribute above the annual contribution limit, and they are also eligible for the Retirement Savings Contribution Credit (aka Saver's Credit).

Contributions are not tax-deductible under federal law, but earnings grow tax-free. Some states may allow a tax deduction if the contribution is to that state's plan. However, any amount remaining in the account after the beneficiary's death is claimed by the state to reimburse it for Medicaid expenses.

Withdrawn earnings are tax-exempt only if the program is established and maintained by a state or its instrumentality, and used to pay for qualified disability expenses, including:

Almost all ABLE plans offer either a debit or prepaid card, or both, to pay for expenses.

Most plans offer multiple investment options, which can be changed twice annually. Most plans also charge asset-and dollar-based fees. Contribution minimums and maximum account balances also vary across plans, so it pays to compare plans.

Officers and employees who control the ABLE program must provide reports as required by the Secretary of the Treasury. A 10% tax penalty applies for:

ABLE accounts not exceeding $100,000 are disregarded for determining eligibility for means-tested federal programs, except for SSI payments for housing expenses. If an ABLE account exceeds $100,000, then SSI payments will be suspended while the ABLE account exceeds $100,000, but will not affect eligibility for Medicaid.

Funds placed in a 529A account by a debtor will be excluded from the debtor's bankruptcy estate if the account beneficiary is the debtor's child, grandchild, stepchild, or step grandchild, but only if the funds are not pledged to get credit, the account was not funded with excess contributions, and the funds do not exceed $6225 for a specified time.

Tax provisions concerning ABLE accounts that will expire after 2025 include:

While 529A accounts are better for caring for the disabled, additional benefits to having a special-needs trust include:

However, only wealthier families can afford it since special-needs trusts typically cost thousands of dollars to set up, and professional trustees who usually manage investing, distributions, and other required duties generally charge 1% of the trust value. People of limited means may use a pooled trust, where assets are commingled with assets of other families and managed by professionals. However, assets remaining after the beneficiary dies may go to the state or to the organization managing the trust. Although a family member can manage a special-needs trust, many will find that they do not have the skill, inclination, or time to do a good job.

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